Europe: The Euro Dra(ch)ma (VGK, EWG, EWI, EUO, IEV, EPV)

Yiannis Mostrous: Since the outset of Europe’s (NYSEARCA:VGK) sovereign-debt crisis, we’ve argued that the EU treaty would need to be revamped to effectively deal with the situation. The EU continues to fail to achieve this goal. There’s plenty of blame to go around, from the sinners in the EU’s southern region, to the pedantic attitude of the Continent’s northern countries.

Over the past year, the debate in the eurozone has been characterized by finger pointing, accusations and chauvinism from all parties. The Continent’s political leadership has proved incapable of handling the crisis in a fashion that will convince the people or the markets of its resolve.

As a result, the tiny, indebted Greek economy has become a symbol of fiscal profligacy. Greece is now seen as the originator of a systemic crisis that could shake the world.

The EU has traditionally implemented change in an incremental fashion. From the outset of the crisis, policymakers adhered to this gradual approach as they feared political repercussions when the public learned of the sacrifices needed to resolve the crisis. Their inaction, which played out in endless meetings in Brussels, has worsened the crisis.

As bond and equity markets endure brutal swings, German Chancellor Angela Merkel recently commented that changes to the EU framework were necessary. She’s right, but she’s also stating the obvious. The deal reached between Greece and the EU at the end of October wasn’t a sustainable solution to the crisis. Greece’s debt burden would have remained onerous and the austerity measures would make economic growth all but impossible.

At present, there are two issues at play. Merkel and French President Nicolas Sarkozy recently informed Greece’s leadership that an EU member nation could be forced out of the common currency if it is unable or unwilling to follow the rule known as the Maastricht convergence criteria. This rule mandates that eurozone countries should not hold debt greater than 60 percent of national income. If debt rises above that level, it should be reduced at a satisfactory pace.

I don’t absolve Greece of its fiscal mismanagement. But Germany’s (NYSEARCA:EWG) debt-to-gross domestic product (GDP) ratio stands at more than 83 percent. France’s debt is 82 percent of its GDP. It’s a far cry from the levels found in Italy and Greece, but the numbers speak for themselves.

It’s preposterous to imagine that the EU would force Italy (NYSEARCA:EWI) —Europe’s third-largest economy—from the common currency. If any country can repair itself without the euro, it’s Italy. Why should the Italians implement reforms or structural changes when the terms of its rescue defeat the very purpose of the bailout?

Nevertheless, EU leaders must make a decision. If they decide to exile fiscally unsound nations from the eurozone, the very nature of the euro experiment will be inexorably changed. But if the EU holds together, the Continent will need better cooperation and fiscal unity.

This brings us to the second issue: fiscal unity. The crisis has proved that a monetary union without fiscal unity can’t work. True fiscal unity, however, will require both debtors and creditors to shoulder the burden. Unfortunately, this means that creditors will have to pay more to bailout their weaker neighbors. But if the euro were to break up, these same creditors would still be forced to rescue a massively leveraged banking sector with high levels of exposure to eurozone sovereign debt.

It’s a tough pill to swallow, but the benefits of a true fiscal union are compelling. The EU would emerge as a potent institution with the power to oversee the fiscal policies of its member nations. In the event of a mounting financial crisis, the European Central Bank can act as a lender of last resort, much like the US Federal Reserve. Regardless of which path Europe chooses, the time to act is now.

Written By Yiannis Mostrous From Global ETF Profits

With his experience in international market analysis and venture financing, Yiannis G. Mostrous is more than just a world traveler; he’s also an expert on identifying investment opportunities in emerging and overlooked markets—the places most of us only see on television. As an analyst with Artemel International, Mr. Mostrous worked with developmental  institutions to promote business development in the Mediterranean, while as an associate in the venture capital Finance & Investment Associates was  involved in analyzing start up companies’ business plans evaluating their  potential while bringing together worthy candidates and angel investor groups.

Since joining Investing Daily, Mr. Mostrous has dedicated himself to helping individual investors bolster their returns and give their portfolios an international flavor. In his financial advisory Global Investment Strategist, Mr. Mostrous identifies top Asian stock market opportunities in fast-growth economies including China and India. Mr. Mostrous has an MBA from Marymount University with a major in Finance and a BBA from Radford University focusing on investments in natural resource markets around the globe. More recently, Mr. Mostrous was lead author of The Rise of the State: Profitable Investing and Geoplitics in the 21st Century.

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